Aiming for Alpha
Opportunities and Challenges
for ETF Investors in Asia

SPECIAL SUPPLEMENT
Editor’s Note

R

obert G. Allen, a famous businessman and author once shared this thought
about investing, “How many mill...
ETF Special Supplement

An “Active” year
for ETFs in 2013
by Deborah Fuhr
each region reached new all-time highs: The Nove...
In the US, the SEC requires ETFs to provide
transparency of their holdings and defines,
active ETFs as funds that do not t...
ETF Special Supplement

Highlighting ETF’s
Areas of Concern
by Deborah Fuhr

F

or some two decades, ETFs
enjoyed seemingl...
concern has been most pointed in Europe
where it is possible to have physically
replicating ETFs and those replicating
usi...
ETF Special Supplement

Asia Pacific
(Ex-Japan) ETF and
ETP Growth
ETF Assets
($US Bn)

ETP Assets
($US Bn)

#of ETFs

#of...
5 Things

to Remember when
Selecting an Advisor
2
1

Remember to check
their background
and credentials

Some planners may...
ETF Special Supplement

Is fee-based
advisory system the key
to unleash investor
demand in Asia?
the investment mix in Asi...
hedge funds, private equities and real estate. I see this trend emerging in Asia and it is
part and parcel of the rising l...
ETF Special Supplement

Understanding
Synthetic ETFs

S

ince the credit crisis shook
up the global financial system
in
20...
Collateral to Offset
Potential Damage
Within the context of a synthetic
replication ETF, counterparty risk is the
risk tha...
ETF Special Supplement

Synthetic ETFs:

A Chief Investment
Officer’s Point of View
Kingsley Jones, Chief Investment Offic...
Main conference: 25 September 2013 n Briefing Focus Day: 24 September 2013
Venue: The Park Lane Hong Kong Hotel, Hong Kong
...
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Aiming for Alpha - Opportunities and Challenges for ETF Investors in Asia

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Aiming for Alpha - Opportunities and Challenges for ETF Investors in Asia

  1. 1. Aiming for Alpha Opportunities and Challenges for ETF Investors in Asia SPECIAL SUPPLEMENT
  2. 2. Editor’s Note R obert G. Allen, a famous businessman and author once shared this thought about investing, “How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case.” Certainly, investors these days know better than just to invest in savings accounts. In many cases, as what we’ve seen in the US recently, savvy investors even go as much as dipping their toes in a pool of exotic investment products just to maximize profits. The merits (or demerits) of such an activity is a different topic altogether but investor activity, as a whole, is generally in an upswing, particularly, the Exchange Traded Fund (ETF) market. According to Deborah Fuhr, Partner at ETFGI and one of the chairperson at the keynote speakers at the coming ETFs Asia 2013 conference happening in Hong Kong, it has been an “active” year for ETFs in 2013. Assets in Exchange Traded Funds (ETFs) and Exchange Traded Products (ETPs) hit an all-time high of over US$1.9 trillion as of November 2012. In Asia Pacific (ex-Japan), ETF Assets as of May 2013 is at US$88.9 billion. The opportunities for ETF investors are arguably aplenty. But challenges, especially in Asia, are also part of the game. In this special report, we’ll take a closer look at ETFs in the Asian context, the role of advisor fees in unleashing investor demand and the ups and downs of synthetic ETFs. Darwin Jayson Mariano IQPC Worldwide 2 w w w. I n d e x E T FA s i a . c o m
  3. 3. ETF Special Supplement An “Active” year for ETFs in 2013 by Deborah Fuhr each region reached new all-time highs: The November 2012 report of ETFGI recorded US$1.3 trillion in US Listed ETFs and ETPs, European listed ETFs and ETPs accounted for US$359 billion, Asia Pacific ex-Japan US$82 billion, Japan US$48 billion, Latin America US$11.6 billion and Middle East and Africa US$22.8 billion. Year-to-date through end of November 2012, ETF and ETP assets increased by 24.2 percent from US$1.5 trillion to US$1.9 trillion. We expect index tracking ETFs and ETPs will continue to contribute to a compounded annual growth rate of 20 to 25 percent over the next few years as more investors embrace using ETFs and ETPs in more asset classes, in larger sized allocation for both tactical and strategic investments and as building blocks for an entire portfolio. Slow growing Actives Deborah Fuhr, Partner, ETFGI is presenting at the ETFs Asia 2013 conference in Hong Kong. To attend, email enquiry@iqpc.com.sg or call +65 6722 9388. I t is safe to say that 2012 has ended as another very good one for Exchange Traded Funds (ETFs) and Exchange Traded Products (ETPs). Globally, we are likely to see record net new asset flows and a record level of assets in ETFs and ETPs go in index tracking ETFs and ETPs as well as in many of the countries and regions where ETFs and ETPs are listed. At the end of May 2013, the global ETF/ For a number of years many commentators have highlighted active ETFs as the next potential significant area of growth for the ETF and ETP industry. To date however, active ETFs have not seen significant growth in terms of number of products or assets. At the end of November 2012 there were 108 active ETFs and ETPs with US$14 billion in assets, accounting for less than 1 percent of all assets invested in ETFs and ETPs. The questions around active ETFs are interesting. Is this move an active or a defensive move by mutual funds to thwart the perceived disruption innovation and threat of ETFs, or is the ETF industry trying to assimilate traditional mutual funds. To begin to understand this we must first consider what “active” actually means. Active funds refer to a portfolio management strategy where the manager makes specific investments with the goal of outperforming a specific benchmark and hence delivering alpha. Active ETFs are not ETFs that are designed to track non-market cap indices as some commentators have suggested. Like many imitations of successful products however, the end result may not have all the benefits and features of the original, so the very principles that underpin the first and traditional ETF may be lacking in this new model. ETP industry had 4849 ETFs/ETPs, with 9875 listings, with a record level of US$2.14 trillion Assets in ETFs and ETPs listed globally hit an all-time high of over US$1.9 trillion and w w w . I n d e x ET F A s i a . c o m Transparency an obstacle to growth We have years of historic data illustrating how difficult it is to find traditional active funds that consistently deliver alpha, and there is no guarantee that Active ETFs will deliver consistent Alpha. 3
  4. 4. In the US, the SEC requires ETFs to provide transparency of their holdings and defines, active ETFs as funds that do not track an index. Successful active equity managers are less willing to provide transparency on their ‘secret sauce’. Some less well-known active equity managers have been willing to run active ETFs with full transparency. These products have had limited success in raising assets and some have been closed. Well known fixed income managers are more likely to offer transparent active ETFs as the benchmarks are much larger and bond investment strategies are harder to copy. Two relatively new and successful active ETFs in the US by PIMCO the Total Return ETF and the Enhanced Short Maturity ETF have gathered approx. US$5.9 billion in AUM. In addition to gaining permission to launch transparent active ETFs and transparent active ETFs which will make use of derivatives, managers in the US are trying to gain permission from the SEC to allow them to manage non-transparent Active ETFs. The proposal includes proxy portfolios designed to mimic the performance of the real holdings while disguising the ETF’s actual holdings and transparency on a quarterly basis both without in-kind creation or redemption. Navigate Fund Solutions is working on developing exchange-traded managed funds, or ETMFs, which will be active non-transparent funds that trade based on a reference to future NAV. These proposals for non-transparent Active ETFs are similar to how exchange listed and traded active open-ended funds have worked in Europe for over 25 years prior to the launch of the first ETF in US in 1993. 4 The alternative breed What the new year holds Euronext offers nearly 200 funds in a segment which operates NAV +/- pricing. Deutsche Borse has over 2,800 funds tradable via continuous auction with specialists on the Xetra. In Denmark more than 420 mostly active UCITS funds are traded on the exchange. They are not identified as ETF’s nor do they want to be, as they do not have the typical ETF characteristics. It is likely that we will see new asset managers enter the ETF industry offering new types strategies as active ETFs in 2013. Since the launch of the first ETF in the US in January 1993, three years after the first ETF was launched in Canada, we have seen that there are many challenges to launching a successful index ETF. The challenges to overcome in launching a successful active ETF are much greater. One of the main challenges is consistently delivering alpha – a challenge most active fund managers find hard to do consistently in mutual funds. In March 2010, the Securities and Exchange Commission’s (SEC) made an announcement of a regulatory review for mutual funds, ETFs, and other investment companies use derivatives. Since that announcement the SEC suspended consideration of exemptive requests under the Investment Company Act of 1940 for actively managed ETFs that invest in derivatives, although some actively managed ETFs were granted SEC relief prior to 2010 were in some cases, permission to use of derivatives. In August 2011, the SEC issued a consultation asking for public comment on derivative use by 40 Act mutual funds and ETFs. On December 6 in New York, Norm Champ, the director of the Securities and Exchange Commission’s (SEC’s) Division of Investment Management, announced that the Division would now consider exemptive requests for actively managed ETFs that intend to invest in derivatives. He said the SEC is still reviewing the issues raised in the consultation, but will now consider exemptive requests relating to actively managed ETFs that use derivatives, but not currently exemptive requests relating to leveraged and, it is assumed, inverse ETFs. Learning the Basics The key characteristics of the index tracking ETFs are: • Transparency – typically the full list of holdings are published daily. • Flexibility – trade and settle like stocks, with intraday pricing and trading, place stop and limit orders, increments of one share and go long or short like a stock. • Cost effectiveness – asset weighted average TER for ETFs is 0.31 percent. • Diversification – exposure to an entire benchmark. • Indicative NAV – real-time value of the underlying portfolio is available • Liquidity – two sources: secondary, volume on exchange and primary, in kind creation/redemption process trading the underlying holdings by authorized participants. Republished article Courtesy of WealthAsia Media (www.wealthasia.net) w w w . I n d e x ET F A s i a . c o m
  5. 5. ETF Special Supplement Highlighting ETF’s Areas of Concern by Deborah Fuhr F or some two decades, ETFs enjoyed seemingly unstoppable progress, with the features inherent to the original ETFs – transparency, liquidity, simplicity, diversification and cost efficiency in a fund wrapper with the ability to buy or sell any time during the trading day - presented this product as a serious challenger to the traditional mutual fund industry. In 2008 however, the events following the Lehman Brothers collapse led to a cold wind blowing over this growth and revealed a dark problem at the core of the ETF industry – counterparty risk. Fears were amplified by the product promoters themselves who argued the detriment of one type of ETF offered by their competitors to the benefit of their alternative model. For retail investors, the issue of counterparty risk had never really existed until the 2008 financial crisis. But the crisis ushered in a new era for the investment product buying public, an era of seemingly untouchable institutions collapsing or seriously wobbling. Such calamities moved the whole question of structural risk – the risk you assume through the method by which an investment exposure is delivered to you – on a par with that investment risk itself. It was indeed ironic that the genesis of w w w . I n d e x ET F A s i a . c o m this concern lay in an exchange traded exposure that was far removed from the principles that underscored the original ETFs. Exchange Traded Notes (ETNs) had become increasingly popular as a way of delivering products speedily to market, often at a discounted cost to the promoter, if not price to the investor, when compared against traditional ETFs. In addition these products allowed investors – institutional and retail – access to exposures that would not be permitted in a traditional fund. While the lack of regulation around investment risk might be understood by an investor – and it remains the case that there must be an issue over retail investors being able to access certain types of exposure on an unadvised basis through purchases on the stock exchanges – the fact that these products traded and settled like ETFs meant the crucial fact that the method by which these exposures were delivered to investors were effectively unregulated. The net effect of this lack of regulation meant that the traditional protections implicit in fund regulation – segregation of assets, diversification of investment exposures, collateralization of exposures and independent oversight – were simply not present. While the promoter might argue this lack of regulation was disclosed in the prospectus of the note this was of cold comfort to the stock market purchaser who may have never even had sight of that document and assumed his ETN or ETC was equivalent to an ETF rather than materially different both in terms of that investment exposure and its deliverance and more particularly its protections. In short, investors in the note were assuming investment risk and full exposure to the issuer. Once this structural weakness in the market was revealed, investors and regulators stood back and took a hard look at all exchange traded exposures. Perhaps the key articulation of concerns was through the report of the Financial Stability Board in 2011, which identified four key areas of concern: • the increasing complexity of exchange trade products such as inverse and leveraged exposures; • concerns around securities lending in physically backed ETFs; • concerns around synthetic ETFs especially where the swap counterpart and the product promoter were part of the same entity; • concerns around non fund exchange traded exposures such as the exchange traded notes discussed above. The debate around these four areas of 5
  6. 6. concern has been most pointed in Europe where it is possible to have physically replicating ETFs and those replicating using derivatives. In the US the latter product is not effectively permitted and equally it is clear there will be for the foreseeable future no further authorization of new leveraged and inverse ETFs as the regulator has been reviewing the use of derivatives in ETFs and mutual funds since 2010. exchange traded funds arose from the It is ironic though that the fears around The evolution of this debate will influence 6 counterparty exposures in notes and while there may be counterpart exposure in synthetic products and in physically backed through securities lending it is within the context of highly regulated fund vehicles. The regulation of notes at a the growth of ETFs in Asia Pacific both in terms of the acceptability of UCITS and non fund structures in the various markets but also in the growth and increased regulation of the local funds industry. The expansion of the exchange traded exposures markets will continue. product level is largely untouched and it appears their accessibility will be limited though distribution channels. Extracted from article “Cautionary tale” by Deborah Fuhr with permission from Benchmark / WealthAsia Media (www.wealthasia.net) w w w . I n d e x ET F A s i a . c o m
  7. 7. ETF Special Supplement Asia Pacific (Ex-Japan) ETF and ETP Growth ETF Assets ($US Bn) ETP Assets ($US Bn) #of ETFs #of ETPs 2005 10 0.1 34 1 2006 18 0.2 48 1 2007 28 0.2 73 1 2008 24 0.5 102 5 2009 40 0.8 135 10 2010 53 1.0 211 12 2011 56 1.0 321 14 2012 87 0.9 409 19 May-13 88.9 0.7 444 19 ETF Assets ETP Assets #ETFs #ETPs 81 450 72 400 63 350 54 300 45 250 36 200 27 150 18 100 9 Assets (US$ Bn) 500 50 0 #ETFs / ETPs 90 0 2005 2006 2007 2008 w w w . I n d e x ET F A s i a . c o m 2009 2010 2011 2012 May-13 Source of information: ETFGI 7
  8. 8. 5 Things to Remember when Selecting an Advisor 2 1 Remember to check their background and credentials Some planners may refer to a college or graduate school diploma and their networks of business partners, but do they really know about retirement and tax planning? Can they help you determine how much insurance you need while suggesting the best way to fund your teenager’s college education? Do they know how your investment should be protected while addressing how a fund is performed. That’s where the need to know their credentials comes in. Present and past experience of an advisor is important. For instance, you can ask what were the four worst investment decisions they have made over the past five years, and how they corrected them. Many designations and qualifications are awarded to those who have trained and passed exams on financial planning. Find out what a planner had to do to earn her credentials and who awarded them. 8 4 Remember to check if they will provide specific recommendations for investments Find out ahead of time if they’ll provide specific handholding or more general directions. Sometimes it will depend on how self-directed you are. You may want someone who’s going to tell you exactly what kind of insurance to get, how much to purchase or what investments to buy. On the other hand, you may feel more comfortable and confident by giving them the ability to pick funds and not offering any input in that department. 3 Remember to check how fees aregoing to be paid The advisor should clearly explain and state in writing how fees will be paid for the services they are providing. The most basic methods of payment are: fees based on an hourly or flat rate, fees based on a percentage of your portfolio value, normally referred to as Assets Under Management (AUM), and commissions paid on transaction. Whether you want your money pro-actively managed, will help determine which model works best for you. Remember to check if they are registered investment advisor with a regulatory body If the advisor is registered, they owe you a fiduciary duty, which is a way of saying that they must put your needs first. Investment professionals who are not registered are held to a lesser standard – normally referred to as “suitability” – which means what they recommend and sell to you should be appropriate for you in accordance with the defined investment suitability guidelines. If the advisor is registered, you should ask for a copy of their registered certificate or reference number. 5 Remember to ask yourself: Do I like this person and their approach? At the end of your meeting, ask yourself: Do I like this person? Is there any chemistry with this advisor? Do they appreciate my needs? After al, you are about to enter into an intimate relationship that will hopefully last a long time. If you have any reservations, move on. There are plenty of qualified advisors out there who would like to help you out. Extracted from article “Checklist for Advisor Selection” by Leong Sue Jean with permission from Benchmark / WealthAsia Media (www.wealthasia.net) w w w . I n d e x ET F A s i a . c o m
  9. 9. ETF Special Supplement Is fee-based advisory system the key to unleash investor demand in Asia? the investment mix in Asia? What are the pros and cons of a “do-it-yourself” approach? In the words of Vincent Chen, Chief Executive Officer of VIT Partners “there are pros and cons that go beyond the dollars and cents.” Darwin Jayson Mariano: In your opinion, is a fee-based advisory system needed in Asia to create investor demand? Vincent Chen, Chief Executive Officer, VIT Partners is presenting at the ETFs Asia 2013 conference in Hong Kong. To attend, email enquiry@iqpc.com. sg or call +65 6722 9388. I n building up an investment portfolio, advisors have always played a pivotal role in maximizing returns. However, since the financial crisis of 2008, Asian investors have changed their investments from complex, often exotic products to simplified products. To create investor demand, some analysts point out that an advisor plays an essential part of the growth process, and therefore, feebased advisory system is essential. How will this system change the dynamics of w w w . I n d e x ET F A s i a . c o m Vincent Chen: For me, It is highly probable that under a fee advisory system, investor demand for ETFs will go up as investing in ETFs is a simple and effective way for financial advisors to help investors get beta exposure. We at VIT believe that a financial advisor should engage the client on their investment goals and recommend the most suitable investment products. Sometimes, this means the client needs alternatives in their portfolio to obtain diversification and alternative alpha. This invariably involves the financial advisor being well versed in a wide range of products including ETFs and providing the client access to the relevant products. The fee-based advisory system would make the advisors accountable for the services they provide and accountable for the growth of their clients’ portfolios. This system is in great contrast with a commission based system which encourages advsiors to increase a great number of transactions regardless of the portfolios’ performance. DJM: How do you foresee a fee-based advisory system to change the dynamics of the investment mix in Asia? VC: Since the financial crisis in 2008, Asian investors have changed their investments from complex products to simplified products. The investors now want transparency in products and fees as well. The move to low-cost ETFs is going hand-in-hand with a shift to fee-based compensation, in which the advisors charge a percentage of the client’s assets. Fee based advisory is likely to take off when the financial advisors prove they can add value to the investor’s portfolio. To attain alpha, financial advisors may suggest that investors take up higher risk products that fall within the investor’s risk tolerance. This often entails allocating a part of the investor’s portfolio to alternatives like commodities, 9
  10. 10. hedge funds, private equities and real estate. I see this trend emerging in Asia and it is part and parcel of the rising levels of maturity and sophistication of the average Asian investors. DJM: Do you think the current “do-it-yourself” investment approach is more cost efficient for the end user? VC: The “do it yourself” investor takes on the challenge of constructing his own portfolio and saves on the financial advisory fee he would otherwise have paid his financial advisors. There are pros and cons to this approach beyond the dollars and cents of the fee. Other than asset allocation and product selection, an investor can benefit from the services of a professional advisor on independent investment risk assessment 10  and wealth management throughout the investor’s life cycle. Missing out on professional insights on managing an investment portfolio especially during market downturn can subject the investor’s portfolio to stress losses that can be avoided and better managed. Further, with alternatives taking an increasingly important role in an investor’s portfolio, a financial advisor like VIT will provide access to such products and critical insights on generating alpha from them. w w w . I n d e x ET F A s i a . c o m
  11. 11. ETF Special Supplement Understanding Synthetic ETFs S ince the credit crisis shook up the global financial system in 2007-2008, investors have become increasingly concerned over products using derivatives. Swapbased ETFs are no exception. The two most common criticisms of synthetic ETFs are their complexity and lack of transparency. In this article, we will try to demystify these funds and shed some light on the risks involved in investing in them. Unlike a cash-based ETF, a synthetic ETF does not hold the underlying index constituents. Instead, it holds a basket of securities which may be completely unrelated to the index it is tracking and to which investors have recourse in case of issuer’s failure. The fund typically will enter into a swap arrangement in which it gives away the performance of the collateral basket in return for the performance of the fund’s reference index. The swap counterparty is usually an investment bank. This structure has been widely embraced in Europe because it reduces tracking error, it is lower in cost and it enhances market access. In fact, today there are more ETFs that use the synthetic replication method than those that use physical replication, although cash-based ETFs have the greater share of assets in Europe. Despite having numerous undeniable advantages, swap-based ETFs bear counterparty and collateral risks that should not be overlooked. w w w . I n d e x ET F A s i a . c o m  11
  12. 12. Collateral to Offset Potential Damage Within the context of a synthetic replication ETF, counterparty risk is the risk that the swap writer fails to fulfill its obligations. The regulators in each market seek to limit risk by requiring issuers to maintain collateral. For example, under UCITS III, this risk is limited to 10%, which means that the ETF issuer or the swap counterparty must provide collateral amounting to at least 90% of the ETF’s net asset value (NAV). The basket of securities held (or pledged) as collateral is marked-to-market on a daily basis to ensure that its value does not fall under the respective regulatory limits within each market. In practice, all ETF issuers maintain a margin of safety, which varies from one provider to another. They all maintain different levels of collateral (measured as a percentage of the funds’ NAV) and reset their swaps at different trigger points. ETF providers set average “minimum collateral” thresholds for their ETFs. Each time the marked-to-market value of the collateral falls under that minimum, the fund provider resets the swap and asks the counterparty to deliver additional collateral (cash or securities). Resetting these swaps brings counterparty exposure to zero as the collateral posted to the fund is typically reset back to 100% of the fund’s NAV. Some providers bring their funds’ collateral back to over 100% (counterparty exposures become negative) while others maintains a minimum counterparty exposure of 2% to 3%, resulting in a permanent undercollateralization. It’s worth noting that all the limits can vary from one asset class to another, depending on their relative levels of volatility. For example, fixed income funds will typically have lower thresholds than equities because they are less volatile. It’s also understood that ETF providers maintain some flexibility around 12  (ii) whenever there is a subscription or redemption at the fund level, and/ or (iii) on a regular basis. Resetting a swap to zero eliminates (temporarily) counterparty exposure. So the more frequent the reset, the better, in terms of investors’ protection--although it does result in additional costs for the fund. these limits so long as the 90% UCITS threshold (10% maximum exposure) is not breached. In terms of best practices, we think it is safe to say that the higher the level of collateralization, the more protection is provided to investors in the event of a counterparty defaulting. Collateral Quality and Frequency of Swap Resets The level of collateralization is not the only factor that should be taken into consideration when assessing investor protections in swap-based ETFs. Various additional factors come into play, in particular the quality of collateral as well as the frequency of swap resets. The collateral will only play a role if the swap provider fails and no replacement is found. In that hypothetical situation, the ETF provider would have to quickly liquidate the substitute basket of assets, which is likely to be uncorrelated to the underlying index. This is the reason why collateral baskets are usually composed of securities that are liquid (blue chip equities, government obligations, etc.) and preferably traded in or near the same time zone as the market where the ETF is traded. Swap-based ETF providers have defined different sets of criteria for what they will accept into their funds’ collateral baskets, with some being more conservative than others. For example, some issuers’ equity ETFs hold only domestic stocks as collateral and rule out investing in other regions’ securities. The issue with holding non-domestic stocks as collateral is that they might not be able to be sold in a timely manner in the event of a default on the part of the swap counterparty due to different trading hours. Another factor worth paying attention to is how frequently the swap is reset. Swaps are usually reset when (i) the exposure to a counterparty reaches the trigger point set by the ETF provider, Room for More Transparency Most leading ETF providers have synthetic replication ETFs. Better tracking and access to new asset classes are undeniable advantages. However, investors need to fully understand the counterparty risk embedded in the swaps and determine the level of risk they feel comfortable with. For that, they need to check the relevant ETF prospectus to see what policies the manager follows. However, in many cases we think the information provided on prospectuses and websites does not fully enable investors to make informed investment decisions. While most ETF issuers have been quite candid with us about the operational details of their collateral policies, they do not disclose them on their websites or in their filings. As far as collateral is concerned, we believe that fund providers should commit to full transparency –as it’s supposed to be one of the key advantages of ETF ownership. Investors should not have to call or send an e-mail to request snapshots of their ETF’s collateral basket. Information like the identity of swap counterparties, the composition of the collateral basket and how often swaps are reset is information investors have the right to know. It should be made readily available to them. Extracted from article “Looking under the hood” by Hortense Bioy with permission from Benchmark / WealthAsia Media (www.wealthasia.net) w w w . I n d e x ET F A s i a . c o m
  13. 13. ETF Special Supplement Synthetic ETFs: A Chief Investment Officer’s Point of View Kingsley Jones, Chief Investment Officer, Jevons Global speaks candidly about the pros and cons of synthetic ETFs and the regulations that are currently in place. He also shares his views on the derivative system in Asia and whether a “blow up” is imminent in the foreseeable future. wrong; counter-party risk in the event of default by a swap or derivative issuer; risk of changed market access regulations; and the basis or performance risk of matching. The pros of synthetic ETFs may include: lower transactional charges within the ETF structure; potentially lower fees if the physical is expensive to trade; and flexibility in market access for restricted market access regimes. Kingsley Jones, Chief Investment Officer, Jevons Global is presenting at the ETFs Asia 2013 conference in Hong Kong. To attend, email enquiry@iqpc.com.sg or call +65 6722 9388. Darwin Jayson Mariano: What are the pros and cons of synthetic replication models vis-à-vis physical ETFs? Our preference is for the physical, where possible. There are additional risks involved with synthetic ETFs over and above the normal market risk and liquidity risk. These include: regulatory risk in respect of recourse if something goes The typical solution to this risk is to place documentation of the product carefully to Kingsley Jones: How secure is the derivative system now, especially in Asia? Do you think there will be a blow up in the foreseeable future? The issue for any potential blow-up is related primarily to Over The Counter (OTC) instruments, since these do not generally have the protection of a central clearing house. The principal problem we forsee is a lack of transparency on cross-border exposures. There is no direct evidence of this, to our knowledge, at this stage. However, the type of instruments which may be at future risk are commodity related derivatives and market access products such as China “A” share vehicles, if the underlying counter-party risks become too concentrated. single counter-party exposure limits into the mandate for the structure. One should always examine the assess these risks. DJM: In your opinion, is enough being done to regulate development of synthetic ETFs? Do you think there is a need for regulatory reform? And in which area/s do you think reform is needed? KJ: We are not a regulator, so we do not pretend to know how to regulate well. We think the likely risk points are connected with the possible concentration of counterparty risk in Over the Counter derivative positions. Regulators will differ in their views on how to handle this. In our view, the central requirement for investor protection should always be fair and accurate disclosure of such risks where they arise. The specific measures a regulator might take to control the growth of any such risks are beyond our competence. Disclaimer: Please note that we do all we can to ensure accuracy and timeliness of the information presented herein but errors may still understandably occur in some cases. If you believe that a serious inaccuracy has been made please let us know. This article is provided for information purposes only. IQPC accepts no responsibility whatsoever for any direct or indirect losses arising from the use of this report or its contents. w w w . I n d e x ET F A s i a . c o m  13
  14. 14. Main conference: 25 September 2013 n Briefing Focus Day: 24 September 2013 Venue: The Park Lane Hong Kong Hotel, Hong Kong INNOVATIVE STRATEGIES TO OPTIMISE ETF PORTFOLIO RETURNS The ETF space in Asia is experiencing exciting times with both bullish and bearish markets. Despite the current volatility, growth in ETF investments has surged and the market is predicted to reach unprecedented levels. Now in its 4th year, IQPC will be running the ETFs Asia 2013 conference this September in Hong Kong and will bring you the most respected names in the ETF industry and the largest gathering of investors under one roof. Distinguishing itself as the most diverse and innovative event in the ETF market in Asia, ETFs Asia 2012 last year attracted over 200 delegates, including investors, portfolio managers, issuers, exchanges, index providers, consultants and many more. EXPERT SPEAKERS THIS YEAR INCLUDE: Alexa Lam Deputy Chief Executive Officer, Hong Kong Securities & Futures Commission Tahnoon Pascha Chief Executive Officer – Equities & Fixed Income, Aviva Investors Asia Graham Bibby Founder and Chief Executive Officer, Richmond Asset Management, Richmond Group Deborah Fuhr Partner, ETFGI Jaekyu Bae Chief Investment Officer, Managing Director, Samsung Asset Management Thomas Furda Equity and Fund Analyst, Independent Researcher Neil Thomas Private Wealth Manager Wealth Management Group Limited Martin W. Hennecke Associate Director Tyche Group Vincent Chen Chief Executive Officer, VIT Partners Ltd Simon Hopkins Chief Executive Officer, Milltrust International Group Dr. Ana Armstrong Managing Director, Armstrong Investment Managers Paul So Head of Beta Products, Enhanced Investment Products Ltd www.IndexETFAsia.com

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